Question

Bellwood Corp. is comparing two different capital structures. Plan I would result in 27,000 shares of stock and $87,000 in debt. Plan II would result in 21,000 shares of stock and $261,000 in debt. The interest rate on the debt is 7 percent. Assume that EBIT will be $100,000. An all-equity plan would result in 30,000 shares of stock outstanding. Ignore taxes.

   

What is the price per share of equity under Plan I? Plan II? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

Plan I: Number of Shares Outstanding = 27000, Debt = $ 87000 and let the price per share be $P

Plan II: Number of Shares Outstanding = 21000, Debt = $ 261000 and let the price per share be $ P

As there are no taxes and EBIT under both plans are equal, as per MM proposition II the total firm value should be the same under both capital structures.

Hence, 27000P + 87000 = 21000P + 261000

P = (261000 - 87000) / (27000 - 21000) = $ 29

NOTE: Firm Value under

Plan I: 87000 + 27000 x 29 = $ 870000

Plan II: 261000 + 21000 x 29 = $ 870000

Plan III: 30000 x 29 = $ 870000